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Markets on edge as US Fed hints at final rate hike

Your mortgage news update for the week of September 22, 2023

Memo 1: The US Fed holds rates, but may have one last hike in store

The US Federal Reserve (the American counterpart to the Bank of Canada) opted to leave its trend-setting Federal Funds Rate unchanged in a range of 5% - 5.25% this week, signalling the economy is starting to respond to past interest rate hikes – but there are lingering concerns.

Of particular focus is the rate of US inflation which has mirrored that of Canada’s; after surging to a high of 9.1% last June, the Fed has toiled to claw CPI back to its target range with a series of 11 rate hikes over the last 18 months. The measure has since dropped to 3.7%, but remains well above the central bank’s ideal 2%. 

“As expected, the Fed kept interest rates unchanged. That makes two holds in three meetings, as the Fed paused in June as well. It’s taking a wait‑and‑see approach, seemingly basing its rate decisions largely on the economic indicators and inflation data,” Francis Généreux, Principal Economist at Desjardins, wrote following the announcement. “This suggests we’re nearing the end of the rate hiking cycle—if we aren’t there already.

However, the Fed has made it clear inflation isn’t out of the woods yet, with the very real possibility of one last hike.

“Given how far we have come, we are in a position to proceed carefully as we assess the incoming data and the evolving outlook and risks,” stated Fed Chair Jerome Powell in a post-announcement press conference. 

“Real interest rates now are well above mainstream estimates of the neutral policy rate, but we are mindful of the inherent uncertainties in precisely gauging the stance of policy. We are prepared to raise rates further if appropriate, and we intend to hold policy at a restrictive level until we are confident that inflation is moving down sustainably toward our objective.”

The Fed’s statement also slashed in half the number of anticipated rate cuts in 2024, from four to two, with the key interest rate remaining higher for longer. 

While the Fed’s hold had been largely anticipated by economists, this persistent uncertainty is keeping markets on edge; treasury and bond yields spiked following the announcement both north and south of the border, while global stocks dipped and currencies flagged against the USD.

The Fed’s next move is anyone’s guess, as future rate hikes will clearly be dependent on what the next economic data releases have to say; a similar sentiment as telegraphed by the Bank of Canada in its own rate-hold announcement on September 6.

“Chair Powell reiterated that monetary policy is already at 'restrictive' enough levels to push inflation pressures lower over time, and that has let policymakers shift to a more 'data-dependent' approach to future interest rate decisions,” writes Nathan Janzen, Assistant Chief Economist at Royal Bank of Canada, in a Daily Economic Update.

“To-date, easing inflation pressures have come without significant increases in unemployment, but labour demand (job openings) has continued to slow, credit conditions have tightened, and the growth backdrop is showing more significant signs of slowing in the rest of the world as headwinds from higher interest rates build. We continue to expect that economic growth and labour markets will soften, but the Fed is also still clearly willing to hike interest rates further if inflation were to show signs of reaccelerating.”

Memo 2: Fixed mortgage rates on the rise as bond yields push 17-year high

Fixed-mortgage-rate shoppers will soon again face climbing borrowing costs, as boiling bond yields amp up the pressure on lenders and their rate funding. The yield for the five-year government bond – which largely sets the base for fixed-rate mortgage pricing – hit the 4.3% range on Wednesday and Thursday, following the latest US Fed announcement.

That’s a high not seen since 2006, and indicates there’s little relief on the horizon for today’s new and renewing mortgage borrowers. The current best five-year fixed rate option rose Friday morning to 5.34%, a whopping 275 basis points higher than the 2.59% available in March 2022 – prior to the start of the BoC’s hiking cycle – and 395 basis points higher than the 1.39% borrowers could have locked into in the early months of 2021. Short-term fixed rates are also on the rise, coming to 6.14% and 5.99% for two- and three-year fixed terms, respectively.

The Canadian yields are following the volatility in the US treasury market, which have surged on fresh expectations the US Fed may hike rates one last time before the end of the year; as rising interest rates devalue bond holdings, investors dump them on fears of impending hikes, driving overall yields higher – and ultimately costs for borrowers.

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Memo 3: The Bank of Canada doesn’t want to get your hopes up

Speaking of the Bank of Canada’s latest rate hold, the central bank released its Summary of Deliberations this week, offering key insights into the thought process behind its September announcement. 

The summary delves into the points of discussion among the Bank’s officials as they mulled over the latest economic data – and while policymakers ultimately chose to leave the Bank’s trend-setting Overnight Lending Rate untouched at 5%, it’s clear they worried doing so could send the wrong message.

“(Governing Council)... considered the possibility that their decision could be misinterpreted as a sign that policy tightening had ended and that lower interest rates would follow,” states the summary. “They agreed that they did not want to raise expectations of a near-term reduction in interest rates, given that they only considered keeping the policy rate where it is or raising it further.”

Translation: Borrowers shouldn’t get their hopes up of interest rate cuts any time soon, given how newly-minted the Bank’s commitment to holding rates is; more time and economic data is needed before anyone can tell with certainty when rates may lower again. 

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